ECB's main target is a weaker euro

The most important anti-recession instrument in the European Central Bank’s package of easing measures went unannounced. It is the implicit target of a much weaker euro.

ECB President Mario Draghi said on Thursday that the main reasons for the decline in euro area inflation from 3% at end-2011 to 0.3% last month were lower energy and food prices (which he can do little about) and the euro’s appreciation (which he and his ECB governing council colleagues can influence).

At his previous press conference on 7 August, Draghi made the extraordinary statement that ‘other central banks have been reducing their exposure to the euro’, more or less inviting holders all over the world to move into the dollar. At the latest briefing on 4 September, the exchange-rate issue received little attention. But the subsequent fall in the euro to $1.29 (from $1.33 in early August and $1.39 in May) indicates that Draghi’s implicit policy is achieving results.

A fall in the exchange rate, possibly towards the $1.20 level in coming months, will increase import prices and bolster euro area companies’ competiveness, helping the ECB to get closer to its target of inflation ‘below but close to 2% over the medium term’.

The further symbolic cut in ECB interest rates, and the announcement of a much-trailed progamme of purchases of asset-backed securities, including covered bonds, bolster the aim of nudging down the euro. However, the lack of unanimity behind what was clearly a rushed decision, and concomitant shortcomings in detail on how the ABS moves will actually work, heighten the risk that the measures will be less than fully effective in spurring credit growth.

The Bundesbank and other northern central banks, which argued for a delay until the underlying liquidity position in the euro area became clearer, will become still more obdurate in opposing the much-discussed but ever more controversial step of full-scale quantitative easing through purchases of government bonds. If this issue moves further up the agenda in coming months, the ECB council might even decide to go ahead with full-scale QE, but without the participation of the Bundesbank, under some kind of legally watertight but politically embarrassing opt-out deal.

The splits on the governing council indicate a deeper divide about the fundamental objectives of monetary union. German policy-makers see nothing much wrong with sub-2% inflation and do not wish the central bank to carry out measures to promote economic growth that they see as the job of governments. Further, they distrust any idea of boosting already-high banking liquidity and revving up parts of the financial markets such as securitisation that they believe were partly responsible for the 2007-08 turbulence.

Many other important Europeans wish the ECB to get fully behind reviving the European economy, on the grounds that it is the only European institution that works properly in conducting economic policy. This division seems unlikely to be overcome – and may become increasingly evident.